"Labor market conditions improved, with the unemployment rate declining further," the Fed said in a statement. "However, a range of labor market indicators suggests that there remains significant underutilization of labor resources."

Wednesday, 30 July 2014

In the US, home prices fell in May, with the S&P/Case Shiller composite index of 20 cities declining 0.3 percent on a seasonally adjusted basis, its first fall since January 2012. However, the Conference Board's consumer confidence index rose to 90.9 in July, the highest level since October 2007, from 86.4 in June.

In Japan, the unemployment rate rose to 3.7 percent in June from 3.5 percent in May. However, the ratio of job offers to job seekers hit 1.10 in June, the highest since June 1992.

Japanese household spending fell 3.0 percent in June from the previous year. However, this was an improvement over the 8.0 percent and 4.6 percent declines in May and April respectively.

In the UK, mortgage approvals jumped 8 percent to 67,196 in June. However, lending to non-financial businesses fell by 3.4 billion pounds in June, its biggest fall since November last year, while unsecured lending to consumers rose by 418 million pounds, the smallest increase since January 2013.

The latest figures "suggest that the impact of the sales tax hike has started to fade," Capital Economics said in a note after the data was released. "We expect core inflation excluding tax to fall below 1.0 per cent in coming months," it added.

However, the eurozone economy showed signs of strengthening on Thursday. Markit's composite PMI for the region rose to 54.0 in July from 52.8 in June. The manufacturing PMI rose to 51.9 in July from 51.8 in June while the services PMI jumped to 54.4 from 52.8.

Meanwhile, a report on Thursday showed that UK retail sales rose just 0.1 percent in June. Nevertheless, that still left retail sales up 1.6 percent in the second quarter compared with the previous quarter, the fastest pace of growth for a calendar quarter in ten years.

Thursday, 24 July 2014

The S&P 500 added just 0.2 percent but that was enough to bring it to a new record high. The STOXX Europe 600 rose 0.1 percent.

Markets rose despite relatively downbeat economic data on Wednesday.

The International Monetary Fund on Wednesday said that it expects the US economy to grow 1.7 percent in 2014, down from its June forecast for 2.0 percent growth. It expects growth to accelerate to 3 percent next year and in 2016.

These data did not dissuade the Reserve Bank of New Zealand from hiking interest rates for the fourth time since March. On Thursday, the RBNZ raised its official cash rate by 25 basis points to 3.5 percent.

However, there is likely to be a pause before further rate hikes.

“It is prudent that there now be a period of assessment before interest rates adjust further toward a more-neutral level,” RBNZ Governor Graeme Wheeler said in a statement in Wellington. “The level of the New Zealand dollar is unjustified and unsustainable and there is potential for a significant fall.”

However, it remains to be seen whether regulation is up to the task. From Bloomberg:

One of the Federal Reserve’s first post-crisis tests of its ability to quash excessive risk-taking using regulatory tools is so far looking like a failure.

The Fed’s Board of Governors told Congress last week that it’s engaged in “strong supervisory follow-up” to guidance given to banks in 2013 to improve their underwriting standards for high-yield loans. Despite those efforts, Chair Janet Yellen said she’s still seeing a “marked deterioration” in quality.

For the first time, more than half of the junk-rated loans arranged in the U.S. this year lack typical lender protections like limits on the amount of debt borrowers can amass relative to earnings. Yellen’s own easy-money policies are boosting demand for such high-yielding products at the same time that she tests her doctrine that financial bubbles should be constrained by supervisory actions, not a general rise in interest rates.

The full risks to financial stability are unlikely to become obvious until the US economy weakens significantly. And that has apparently not happened yet.

The Chicago Federal Reserve reported on Monday that its national activity index dipped to +0.12 in June from +0.16 in May. The three-month moving average fell to +0.13 from +0.28.

According to the Chicago Fed, the three-month reading shows that economic growth was somewhat above its historical trend.

Monday, 21 July 2014

Many analysts think that the United States stock market is now overvalued.

A Bloomberg poll showed last week that forty-seven percent of financial professionals surveyed said that the equity market is close to unsustainable levels while fourteen percent already saw a bubble.

Federal Reserve Chair Janet Yellen told the Senate Banking Committee last week that equity valuations “remain generally in line with historical norms” even as the Fed's Monetary Policy Report accompanying her testimony noted that valuations for smaller companies in social-media and biotech industries appear “substantially stretched”.

However, on Friday, Cullen Roche at Pragmatic Capitalism wrote a post questioning the value of valuation measures for the stock market.

In the case of the stock market we’ve now seen a 20+ year period where stocks are “overvalued” by several metrics (Shiller CAPE, Tobin’s Q, Market cap to GDP, etc). So I think it’s worth asking yourself how useful all of these metrics really are. Can you afford to go through a 20 year period relying on a rear view mirror dataset assuming that the market is overvalued when the other participants might not be using the same gauge of “beauty” as you are?

John Hussman thinks that valuation measures can be useful though. In a post earlier last week, he showed a chart of various valuation measures for the stock market over the past few decades and correlated them with subsequent 10-year returns for the S&P 500.

He concluded that valuation measures have “provided clear guidance about expected market returns across a century of market history” and have “not failed at all even in recent decades”.

In any case, by most of the valuation measures commonly used, Hussman's chart showed that the stock market has not been obviously overvalued throughout the whole of the past 20 years. It was only so around 2000, when valuations reached a point which correlated with negative return for the next ten years.

Indeed, in late 2008 and early 2009, the stock market was actually undervalued, as Hussman noted in real time back in October 2008. From the latter post:

Stocks are now at the same valuations that existed at the 1990 bear market low. Relative to 30-year Treasury yields, the S&P 500 is priced to deliver the highest excess return since the early 1980's.

The current bull market in stocks took off from the base of undervaluation back in late 2008 and early 2009.

In any case, “overvaluation” is actually a subjective term, as Hussman explained last week.

A widespread misunderstanding comes in when people start using the phrase “fair value.” For any given set of expected future cash flows, if you tell me the price, I can tell you the long-term return, period. If you tell me the long-term return, I can tell you the price, period. Nothing changes this. If you want to say that lower interest rates “justify” a low expected return, and therefore justify a higher price, that’s fine. Just understand that the low expected return will still follow that higher price. If you want to say that in a zero interest rate world, stocks should be priced for zero expected returns over the next 8 years, I have no problem with the conclusion that under that assumption, stocks are at “fair value” here. Just understand that under that conception of “fair value” stocks can still be expected to return nothing over the next 8 years. What is emphatically not true, and not mathematically consistent, is to say that low interest rates “justify” a low expected return, and therefore justify a higher price, but then to turn around and say that since stocks are “fairly valued” under that assumption, they can be expected to achieve normal returns in the future.

It is useful to remember that when Hussman talked about expected return, he was referring to long-term return. In the short term though, valuation measures alone cannot determine when an “overvalued” market corrects.

Indeed, Hussman had written back in December 2006 that bull markets can end in a “speculative blowoff”. That turned out to be prescient. While Hussman noted that the stock market by then had already become overvalued, that cycle's bull market went on for almost another year before finally crumbling.

So while long-term returns correlate quite well with valuation measures, if the short term is the concern, Roche is probably correct in doubting whether valuation measures alone can be relied on to determine one's investment stance.

Meanwhile, there were signs on Friday that China's property market has cooled further. The National Bureau of Statistics reported that new home prices fell in June in 55 of 70 cities surveyed, up from 35 cities in May.

Calculations by Reuters showed that average new home prices in the 70 cities fell 0.5 percent in June, faster than the 0.2 percent fall in May.

Friday, 18 July 2014

Thursday saw a flight to safety in financial markets as tension escalated in Ukraine and the Middle East. The S&P 500 fell 1.2 percent, the US 10-year Treasury yield fell six basis points to 2.46 percent and gold rose 1.3 percent.

The decline in stocks also comes as investors have become increasingly concerned about market levels. A Bloomberg poll showed that forty-seven percent of financial professionals surveyed said that the equity market is close to unsustainable levels while fourteen percent already saw a bubble.

Adding to the negative sentiment, US housing data on Thursday came out weak. Housing starts fell 9.3 percent in June to a nine-month low while building permits fell 4.2 percent, its second consecutive decline.

A report on Wednesday showed that China's economy accelerated in the second quarter. It grew 7.5 percent in the second quarter from a year ago, faster than the 7.4 percent growth in the first quarter.

In June, industrial production rose 9.2 percent from the previous year, retail sales increased 12.4 percent and fixed asset investment rose 17.3 per cent in the first six months compared to the same period the previous year.

Wednesday, 16 July 2014

Investor sentiment was not exactly boosted by remarks by Federal Reserve Chair Janet Yellen on Tuesday. In her testimony to the Senate Banking Committee, Yellen reiterated the view that “a high degree of monetary policy accommodation remains appropriate”.

However, while she said that real estate, equity, and corporate-bond valuations “remain generally in line with historical norms”, she added that in the lower-rated corporate debt market, “valuations appear stretched”, while the Fed's Monetary Policy Report accompanying her testimony noted that valuations for smaller companies in social-media and biotech industries appear “substantially stretched”.

US economic data on Tuesday were mostly positive though.

US retail sales rose 0.2 percent in June. Sales were dragged down by an unexpected 0.3 percent decline in auto sales.

In China, a report on Tuesday showed that bank lending rose to 1.08 trillion yuan in June from 870.8 billion yuan in May. Total social financing rose to 1.97 trillion yuan from 1.4 trillion yuan. M2 money supply rose 14.7 percent in June from the previous year after rising 13.4 percent in May.

In the UK, a report on Tuesday showed that consumer prices rose 1.9 percent in June from the previous year, well up from 1.5 percent in May.

Monday, 14 July 2014

Individual investors are coming back into the stock market. From Bloomberg today:

Individual investors are plowing money back into the U.S. stock market just as professional strategists say gains for this year are over. About $100 billion has been added to equity mutual funds and exchange-traded funds in the past year, 10 times more than the previous 12 months, according to data compiled by Bloomberg and the Investment Company Institute.

The growing optimism contrasts with forecasters from UBS AG to HSBC Holdings Plc, who say the stock market will be stagnant with valuations at a four-year high. While the strategists have a mixed record of being right, history shows the bull market has already lasted longer than average and individuals tend to pile in at the end of the rally.

“If Wall Street, after poring over all known data, comes up with a target and we’re already there, and you still see individual investors buying and they’re typically the ones that are late to the party, it would seem there is limited upside,” Terry Morris, a senior equity manager who helps oversee about $2.8 billion at Wyomissing, Pennsylvania-based National Penn Investors Trust Co., said in a July 8 phone interview.

It may be late in the party but some fund managers still see gains to come.

For Laszlo Birinyi of Birinyi Associates Inc., stocks have entered what he calls the exuberance phase, the last of four stages usually seen in bull markets. He still sees more gains to come, citing the skepticism on Wall Street as a sign that plenty of investors haven’t bought shares yet...

The bull market...is closer to the end than the beginning, said Walter Todd...chief investment officer at Greenwood Capital Associates LLC...

“To the extent that investors start to put a lot of money into the market, it would certainly be late,” Todd said in a July 9 phone interview from Greenwood, South Carolina. “But to say that the end is going to happen in the next few months, I don’t agree with that.”

Portugal's Banco Espirito Santo sought to reassure investors on Friday, saying that “the potential losses resulting from the exposure to Grupo Espirito Santo do not compromise the compliance with the regulatory capital requirements”.

But investors, especially in the US, seem eager to downplay risks anyway. From Bloomberg:

When the U.S. stock market opened yesterday, the Standard & Poor’s 500 Index (SPX) was poised for the first 1 percent drop in three months. Then the bulls stepped in.

The U.S. equity benchmark pared most of its losses during the day, closing down 0.4 percent amid speculation the initial selloff was overdone. Any slump in the market will be temporary and represents a good time to buy, said Craig Hodges, manager of the $1.4 billion Hodges Small Cap Fund that’s beaten 99 percent of its peers over three years.

“We have a list of 15 to 20 names that we’d like to buy at a cheaper price, and so we kind of like days like today, where some of the weak holders get shaken out of stocks,” he said in a phone interview yesterday from Dallas. “There is still a lot of money on the sideline that’s looking to be put to work.”...

“This is the self-fulfilling condition we’ve all been waiting for,” [Greg] Taylor, a fund manager at Aurion Capital in Toronto, which manages about C$6.6 billion ($6.2 billion), said in a phone interview. “We’re getting our buy tickets ready.”...

“There’s still too much sideline cash,” [Mark Luschini, chief investment strategist at Janney Montgomery Scott LLC] said by phone... “Too many under-invested institutional investors that would quickly come into the market and serve to put a floor in before this got ridiculous.”

US stocks rose despite publication of the minutes of the Federal Reserve's June monetary policy meeting showing that some Fed officials were concerned that investors may be growing too complacent about the economic outlook. From Bloomberg:

“Signs of increased risk-taking were viewed by some participants as an indication that market participants were not factoring in sufficient uncertainty about the path of the economy and monetary policy,” the minutes showed.

However, perhaps investors have reason to be complacent, at least with regards to monetary policy.

Officials agreed they must monitor markets for signs of froth and said that if necessary, supervisory measures should be used to “address excessive risk-taking and associated financial imbalances”...

“The Fed is still the investor’s friend, not something to be feared,” said Brian Jacobsen, who helps oversee $231 billion as chief portfolio strategist at Wells Fargo Advantage Funds in Menomonee Falls, Wisconsin. “Where there are bubbles, the Fed will use its role as a regulator and supervisor to address those problems. It will not use monetary policy.”

Earlier on Wednesday, a report from China suggests that there is also little likelihood of monetary tightening by the People's Bank of China in the near future. The National Bureau of Statistics reported that China's inflation rate slowed to 2.3 percent in June from 2.5 percent in May.

Tuesday, 8 July 2014

Bloomberg reports that there are signs that a fall in productivity growth may boost inflation in the US.

Federal Reserve Chair Janet Yellen faces an economy that is starting to look more like Arthur Burns’s in the 1970s than Alan Greenspan’s in the 1990s.

Productivity growth is slowing, just as it was when Burns headed the central bank, not accelerating as it did under Greenspan’s watch. Business output per hour excluding agriculture has risen at a 1.4 percent average annual rate since the recession ended in June 2009 as hiring has picked up while economic growth has lagged behind.

That result is in line with the 1.5 percent rate from 1973 to 1977 and less half of the 3 percent pace from 1996 to 2000, Labor Department data show. The post World War II average is 2.3 percent.

To understand why this is important, look at what happened to the U.S. in each of those periods.

In the late 1990s, increased worker efficiency allowed Greenspan to countenance a fall in the unemployment rate to a 30-year low of 3.8 percent in April 2000 as companies could pay employees more without having to raise prices. In the 1970s, a sudden downshift in productivity growth caught Burns by surprise and led to a rise in consumer prices of more than 10 percent after oil costs surged.

Some economists are concerned about whether the Fed will adjust in time to the recent trend.

“There is a risk,” said former Fed Vice Chairman Alan Blinder.. “You do have the possibility of replaying in the same direction what happened after 1973...”

What it does mean is that Yellen and her Federal Open Market Committee colleagues must be a “little more cautious” about keeping short-term interest rates near zero in their pursuit of lower joblessness, said Blinder...

“We are facing a problem of rising inflation,” said Martin Feldstein, a professor at Harvard University... The Fed is “probably going to respond too weakly, too slowly,” he added...

Long-term interest rates are “going to go a lot higher,” with the yield on the 10-year Treasury note eventually hitting 4 percent, as price pressures intensify and the Fed lags behind in its response, according to Joe LaVorgna, chief U.S. economist at Deutsche Bank Securities Inc.

While the world's largest economy starts worrying about inflation, economic data on Monday from the second and third largest developed economies suggest that maintaining growth remains the concern.

In Germany, industrial production fell 1.8 percent in May, the third consecutive decline. The economy ministry said the decline in output was primarily due to the timing of the 1 May holiday and should only be temporary.

Monday, 7 July 2014

The International Monetary Fund is expected to lower its global growth forecasts. From Bloomberg:

International Monetary Fund Managing Director Christine Lagarde signaled a cut in the institution’s global growth forecasts, saying investment is still weak and that risks remain in the U.S. even as its rebound accelerates.

“The global economy is gathering speed, though the pace may be a bit less than we previously predicted because the growth potential is lower and investment” spending remains lackluster, Lagarde told the Cercle des Economistes conference in Aix-en-Provence, France.

... The IMF is preparing to update its economic forecasts this month after predicting April 8 that the global economy will expand 3.6 percent this year and 3.9 percent in 2015.

Growth in the U.S., the world’s largest economy, is set to accelerate in coming months and Asia’s emerging market economies will avoid a hard landing, though the European recovery is still not as strong as it should be, Lagarde said.

Gavyn Davies summarises the view of the BIS as well as that of central banks with regards to monetary policy and its impact on financial stability:

The BIS views the crash as the culmination of successive economic cycles during which the central banks adopted an asymmetric policy stance, easing monetary policy substantially during downturns, while tightening only modestly during recoveries...

In contrast, the mainstream central bank view denies that monetary policy has been biased towards accommodation over the long term. Ms Yellen’s speech claims that higher interest rates in the mid 2000s would have done little to prevent the housing and financial bubble from developing. She certainly admits that mistakes were made, but they were in the regulatory sphere...

Davies states that “my own view is usually fairly close to the Fed/Yellen mainstream”. But he reminds us:

The BIS was right about the dangers of risky financial behaviour prior to the crash. That caused the greatest demand shock for a century. Keynesians, including the Chair of the Federal Reserve, should be more ready to recognise that the same could happen again.

Similarly, Business Insider quotes FactSet’s John Butters as saying that the forward P/E ratio of the S&P 500, at 15.7, is now well above the 5-year and 10-year averages, although still below the 15-year average and not close to the higher P/E ratios recorded in the early years of this period.

“It is interesting to note that the forward 12-month P/E ratio would be even higher if analysts were not projecting record-level EPS for the next four quarters,” added Butters.

European stocks have also reached elevated valuation levels. According to Bloomberg, the STOXX Europe 600 is now trading at 15.7 times the estimated earnings of its members, the highest since 2009.

European stocks did fall on Friday while the US stock market was closed for the Independence Day holiday. The STOXX Europe 600 fell 0.3 percent.

Friday, 4 July 2014

Markets rose on Thursday, with the Dow Jones Industrial Average in particular climbing 0.5 percent to close above 17,000 for the first time ever. The S&P 500 rose 0.6 percent while the STOXX Europe 600 rose 0.9 percent.

Market sentiment was boosted by data on Thursday showing strong jobs growth in the US. Non-farm payrolls rose by 288,000 in June, helping to push the unemployment rate down from 6.3 percent in May to 6.1 percent, the lowest since September 2008.

There were other indications on Thursday that the US economy is growing.

The Institute for Supply Management’s non-manufacturing index came in at 56.0 in June, down from 56.3 in May. However, Markit's services index rose to 61.0 in June, a record high, from 58.1 in May, pushing the composite index to 61.0, also a record high, from 58.4.

Another report on Thursday showed that the US trade deficit narrowed in May as exports rose 1.0 percent to a record high while imports fell 0.3 percent.

In the euro area, reports on Thursday showed that Markit's composite PMI fell to 52.8 in June from 53.5 in May as the services PMI fell to 52.8 from 53.2 while retail sales were flat in May.

However, the European Central Bank gave investors in Europe something to cheer about on Thursday by leaving interest rates unchanged at its monetary policy meeting, with its president Mario Draghi announcing at a press conference afterwards that those rates “will remain at present levels for an extended period”.

Elsewhere in Europe on Thursday, a report from Markit showed that its UK composite index fell to 58.4 in June from 59.1 in May after the services index fell to 57.7 from 58.6.

Monetary policy faces “significant limitations” as a tool to counter financial stability risks, Federal Reserve Chair Janet Yellen said on Wednesday, adding that heading off the U.S. housing bubble with higher interest rates would have caused major economic damage.

Weighing in on a global debate, Yellen reiterated her view that regulation - not rate policy - needs to play the lead role in combating excessive financial risk-taking.

“The potential cost ... is likely to be too great to give financial stability risks a central role in monetary policy discussions,” Yellen said at an event sponsored by the International Monetary Fund.

However, if fear of bubbles is unlikely to push her to tighten monetary policy, better US economic growth could.

Another report on Wednesday showed that US factory orders fell 0.5 percent in May. However, excluding military equipment, orders rose 0.2 percent. Orders for non-military capital goods other than aircraft rose 0.7 percent.

The Bank of England has also been slow in tightening monetary policy to head off financial bubbles. On Wednesday, its chief economist, Andy Haldane, said that monetary policy is “a last line of defence” for preventing financial stability risks, not a first line of defence.

However, those risks could be increasing after UK house prices rose 1.0 percent in June, taking the annual rate of increase to 11.8 percent, the biggest since January 2005, according to a report from Nationwide on Wednesday. London house prices surged 25.8 percent from a year earlier, an annual increase not seen since 1987.

The strong housing market has boosted construction activity in the UK. Another report on Wednesday showed that the Markit/CIPS construction PMI rose to 62.6 in June from 60.0 in May.

Wednesday, 2 July 2014

The S&P 500 climbed 0.7 percent to an all-time high. That helped push the MSCI All-Country World Index up 0.6 percent to an all-time high as well.

Stocks rose amid mostly positive economic data on Tuesday.

In the US, Markit reported that its US manufacturing PMI rose to 57.3 in June, the highest reading since May 2010, while the Institute for Supply Management reported that its manufacturing PMI fell slightly to 55.3 in June from 55.4 in May.

Other reports from the US showed that auto sales rose 1.2 percent in June to the highest since July 2006 while construction spending rose 0.1 percent in May.